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Why Risk Is to the Downside on QE3

QE3: Risk is to the downside.

United States Federal Reserve
Tetra Images | Getty Images
United States Federal Reserve

The market is anticipating a third round of quantitative easing (QE3) immediately; some surveys say three-quarters expect the Federal Reserve to move at Thursday's meeting.

The stock market is anticipating this as well: the S&P 500 index is at 4.5-year highs; in fact; we are only about 8 percent from an historic high.

If the Fed postpones outright QE3 into, say, December, the market will likely be disappointed. Merely extending low interest rates into 2015, or reducing the interest the Fed pays banks on their excess reserves, will not likely move the markets. (Read More: 5 Reasons Why QE3 Is Unlikely.)

Even an Operation Twist-type announcement may not be enough to move the markets.

There is a substantial group who believe that even an announcement of QE3 may not move the markets appreciably, unless it is rather large. That's why the risk is to the downside.

If the Fed does not start QE3 immediately, the U.S. dollar, Aussie dollar, and yen will likely sell off, as would risk-on stocks like materials and industrials.

Don't get me wrong: Plenty of people would like to see the markets sell-off. Why? Because most people are not all-out long. Second, a lot of people are underperforming, so a drop would bring their performance more in line with the markets. Third, there are a lot of people who would like to buy the market at lower prices. We are at four-year highs, after all.

Elsewhere:

1) Will volatility increase? You can watch people trading the volatility products (like the VXX), and you can watch them selling the VXX in the last week as attempts to play higher volatility has failed. Again and again. (Read More: Low Volatility Might Help Stocks in Fourth Quarter.)

Nobody believes me, but absent a truly huge, outsized event, volatility has been low and will likely remain low. First, the Fed's programs are supporting the markets. That limits downside risk. Second, I am not an expert on options, but from what I hear there has been an awful lot of call buying to offset all the put buying. This dampens implied volatility.

Post Fed meeting, attention will turn to the November presidential elections and the state of the global economy. Here is the big question: Have the economies of China and Europe bottomed in third or fourth quarters, or is the bottoming well into 2013 or beyond?

2) The Dutch elections were a resounding defeat for the anti-euro crowd. Far right and far left parties, which had both campaigned against a closer Europe, were resoundingly defeated. Center right and center left parties, which had supported aid for Spain, gained ground.

3) Italian three-year borrowing costs dropped to 2.75 percent, their lowest level in nearly two years, in an auction that drew tepid demand. The Italian government also paid less to sell its first 15-year bond in more than a year.

4) Pier 1 Imports is set to open at a 7.5-year high, climbing 1.8 percent pre-market, after raising its full-year guidance as same-store sales and store traffic increase. The home-furnishing retailer reported second-quarter earnings per share of $0.19, in line with the Street’s view. Pier 1 expects 2013 earnings per share to come in between $1.10 and $1.16, up from a previously forecast range of $1.08 to $1.14; analysts estimate 2013 earnings per share of $1.16. The company reported second-quarter same-store sales up 6.7 percent and predicted 2013 same-store sales in the mid-single-digit range.

—By CNBC’s Bob Pisani

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  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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